[Federal Register Volume 63, Number 22 (Tuesday, February 3, 1998)]
[Notices]
[Pages 5579-5584]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-2524]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39581; File No. SR-CBOE-97-38]


Self-Regulatory Organizations; Order Granting Approval and Notice 
of Filing and Order Granting Accelerated Approval of Amendment No. 1 to 
the Proposed Rule Change by the Chicago Board Options Exchange, Inc., 
Relating to Listing and Trading Standards for Index Portfolio Receipts

January 26, 1998.

I. Introduction

    On August 14, 1997, the Chicago Board Options Exchange, Inc., 
(``CBOE'' or ``Exchange'') submitted to the Securities and Exchange 
Commission (``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt new Interpretation .02 
to Rule 1.1, Rule 30.10, Interpretation .03 to Rule 30.20, 
Interpretation .01 to Rule 30.33, Rule 30.36, Rule 30.54, Rule 30.55, 
Rule 31.5 and Rule 31.94 to provide for the listing and trading of 
Index Portfolio Receipts (``IPRs''), which are securities issued by a 
unit investment trust and holding a portfolio of securities linked to 
an index.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change together with the substance of the 
proposal was published for comment in the Federal Register on October 
9, 1997.\3\ No comments were received on the proposal. The Exchange 
filed Amendment No. 1 to the proposed rule filing on January 16, 
1998.\4\ This order approves the proposal.
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    \3\ Securities Exchange Act Release No. 39189 (October 2, 1997), 
62 FR 52798.
    \4\ The amendment withdraws a proposed general exemption of IPRs 
from the Exchange's short sale rule. See letter from Ilan Huberman, 
Schiff, Hardin & Waite (CBOE counsel), to Kevin Ehrlich, Attorney, 
Division of Market Regulation (``Division''), Commission, dated 
January 16, 1998.
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II. Background and Description

    The Exchange proposes to adopt new Interpretation .02 to Rule 1.1, 
Rule 30.10, Interpretation .01 to Rule 30.33, Rule 30.36, Rule 30.54, 
Rule 30.55, Rule 31.5 and Rule 31.94 to accommodate trading on the CBOE 
of IPRs, i.e., securities which are interests in a unit investment 
trust (``Trust'') holding a portfolio of securities linked to an index. 
Each Trust will provide investors with an instrument that (i) closely 
tracks the underlying portfolio of securities, (ii) trades like a share 
of common stock, and (iii) pays holders of the instrument periodic 
dividends proportionate to those paid with respect to the underlying 
portfolio of securities, less certain expenses (as described in the 
Trust prospectus).\5\
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    \5\ The CBOE has a request pending before the Division seeking 
exemptive, interpretive, or no-action relief from Rules 10a-1, 10b-
7, 10b-10, 10b-13, 10b-17, 11d1-2, 15c1-5, 15c1-6 and Rules 101, 102 
and 104 of Regulation M under the Act and Section 16 of the Act, 
relating to IPRs.
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    The proposed rules are substantially similar to existing rules of 
the American Stock Exchange (``AMEX'') applicable to Portfolio 
Depository Receipts (``PDRs''), which are substantively very similar to 
IPRs.\6\ IPRs will be issued by one or more Trusts to be formed by an 
entity serving as the sponsor for the Trusts (the ``Sponsor'').\7\ Upon 
receipt of securities and cash in payment for a creation order placed 
through the Distributor as described below, the Trustee will issue a 
specified number of IPRs referred to as a ``Creation Unit.''
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    \6\ See File No. SR-AMEX-92-18 (adopting new rules related to 
the listing and trading of PDRs); SR-AMEX-95-16 (providing that the 
minimum tick applicable to the MidCap SPDR, a PDR product, will be 
1/64 of $1.00); SR-AMEX-94-52 (listing and trading of MidCap 400 
SPDRs under the rules originally adopted to trade PDRs); SR-AMEX-93-
41 (limiting the AMEX's liability in connection with its 
administration of proprietary indices and products); and SR-AMEX-92-
45 (providing that the minimum tick applicable to SPDRs will be \1/
32\ of $1.00).
    \7\ The CBOE anticipates that all of the Trusts will be governed 
by a master trust agreement providing for the issuance, in series, 
of IPRs based on different underlying indices. The Sponsor will file 
(i) a registration statement under the Investment Company Act of 
1940 (``Investment Company Act'') registering the trust (consisting 
of such series of Trusts) as an investment company under the 
Investment Company Act, and (ii) a separate registration statement 
under the Securities Act of 1933 (the ``Securities Act'') 
registering the offer and sale of each series of IPRs. The Sponsor 
will also file an application under Section 6(c) of the Investment 
Company Act requesting exemption of the Trusts and the Sponsor from 
certain provisions of the Investment Company Act and permitting the 
Trusts and the Sponsor to engage in certain affiliated transactions 
otherwise prohibited by Section 17(d) of the Investment Company Act 
and Rule 17d-1 thereunder. The Commission notes that no Sponsor has 
been identified as of the date of the approval order.
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    Each series of IPRs will be based on a published index or portfolio 
of securities. IPRs of each such series are intended to produce 
investment results that generally correspond to the price and yield 
performance of the component common stocks of the selected index or 
portfolio. Each Trust will provide investors with an interest in a 
portfolio of securities that is intended to closely track the value of 
the index or portfolio on which it is based. IPRs will trade like 
shares of common stock and will pay periodic dividends proportionate to 
those paid

[[Page 5580]]

with respect to the underlying portfolio of securities, less certain 
expenses, as described in the prospectus for each series of IPRs. The 
Exchange expects that the Trusts will terminate 125 years from the 
initial date of deposit of the trust corpus into each respective Trust 
or on such earlier date as may be required in order to permit such 
Trust to comply with the rule against perpetuities, in the event that 
the Trust is governed by the law of a state in which the rule against 
perpetuities remains in effect.\8\
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    \8\ Each Trust however may be terminated earlier under the 
following circumstances: (1) Delisting of the IPRs issued by such 
Trust by the primary market on which the IPRs are traded; (2) 
termination of the license agreement with the owner of the index on 
which the Trust is based; or (3) if either the Trustee, Sponsor, 
Distributor, Depository Trust Company (``DTC'') or the National 
Securities Clearing Corporation (``NSCC'') is unable to perform its 
functions or duties with respect to operation of a Trust and a 
suitable successor entity is unavailable. In addition, the Sponsor 
may also terminate a Trust if, after six months from inception, the 
Trust net asset value falls below $150 million or such other amount 
as may be specified in the prospectus, or if, after three years from 
inception, the Trust net asset value falls below $350 million or 
such other amount as may be specified in the prospectus. IPRs cannot 
be traded after the termination of a Trust. However, on termination 
the Trust will be liquidated, and IPR holders at that time will 
receive a distribution equal to their pro rata share of the assets 
of the Trust, net of certain fees and expenses.
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    The Sponsor will enter into a trust agreement with a trustee in 
accordance with Section 26 of the Investment Company Act. The CBOE will 
establish a relationship with an entity that will act as the 
underwriter of IPRs on an agency basis (``Distributor''). All orders to 
create IPRs in Creation Units will be required to be placed with the 
Distributor, and it will be the responsibility of the Distributor to 
transmit such orders to the Trustee. The Distributor will be a 
registered broker-dealer and a member of the National Association of 
Securities Dealers, Inc. (``NASD'').
    Payment with respect to creation orders for a Trust placed through 
the Distributor will be made by (1) the ``in-kind'' deposit with the 
Trustee of a specified portfolio of securities that contains 
substantially the same securities in substantially the same proportions 
or ``weighting'' as the component securities of the index or portfolio 
on which the Trust is based and (2) a cash payment sufficient to enable 
the Trustee to make a distribution (``Dividend Equivalent Payment'') to 
the holders of beneficial interests in the Trust on the next dividend 
payment data as if all the securities had been held for the entire 
accumulation period for the distribution, subject to certain specified 
adjustments (see ``Distributions'' below) plus or minus a ``Balancing 
Amount'' to compensate for any differences between the market value of 
the securities paid and the net asset value of a Creation Unit of such 
Trust. The Dividend Equivalent Payment and the Balancing Amount are 
collectively referred to as the ``Cash Component.'' The portfolio of 
securities and the Cash Component accepted by the Trustee are referred 
to as the ``Portfolio Deposit.''

Issuance of IPRs

    Upon receipt of a Portfolio Deposit for a Trust in payment for a 
creation order placed through the Distributor as described above, the 
Trustee will issue a specified number of IPRs of that Trust equal to 
the Creation Unit. IPRs may be created only in a Creation Unit or 
multiples thereof. The Exchange anticipates that a Creation Unit for a 
series of IPRs will consist of 50,000 IPRs or such other number as the 
Exchange may designate taking into account the value of individual IPRs 
of that particular series and such other factors as the Exchange deems 
to be relevant. It is anticipated that the Trust and Sponsor will 
obtain necessary regulatory approval to allow individual IPRs to be 
traded in the secondary market similar to other equity securities.\9\ 
It is excepted that Portfolio Deposits will be made by institutional 
investors and arbitragers as well as Market-Makers and Designated 
Primary Market-Makers as defined in the CBOE's rules.
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    \9\ At such time as the Exchange seeks to list series of IPRs, 
the Sponsor and the Trusts will file with the Commission an 
application seeking, among other things, an order: (1) Permitting 
secondary market transactions in IPRs at negotiated prices, rather 
than at a current public offering price described in the prospectus 
for the applicable series of IPRs as required by Section 22(d) of 
the Investment Company Act and Rule 22c-1 thereunder; and (2) 
permitting the sale of IPRs to purchasers in the secondary market 
unaccompanied by a prospectus, when prospectus delivery is not 
required by Section 4(3) of the Securities Act but may be required 
according to Section 24(d) of the Investment Company Act for 
redeemable securities issued by a unit investment trust. These 
exemptions, if granted, will permit IPRs to be traded in secondary 
market transactions just as interests in a closed-end investment 
company are traded.
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    To maintain the correlation between the portfolio of securities 
held in a Trust and that of the underlying index or portfolio, the 
Trustee will adjust the composition of the Portfolio Deposits from time 
to time to conform to changes to the index or portfolio made by the 
organization that compiles and maintains such index or portfolio. The 
Trustee will aggregate certain of these adjustments and make periodic 
conforming changes to the Trust portfolio.
    It is expected that the Trustee or Sponsor will make available (a) 
on a daily basis, a list of the names and required number of shares for 
each of the securities in the then current Portfolio Deposit for each 
of the Trusts; (b) on at least a minute-by-minute basis throughout the 
day, a number representing the value (on a per IPR basis) of the 
securities portion of each Portfolio Deposit; and (c) on a daily basis, 
the accumulated dividends, less expenses, per each outstanding IPR 
unit.
    Transactions in IPRs may be effected on the Exchange until 3:15 
p.m. Chicago time each business day.\10\ IPRs will trade in round lots 
of 100.
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    \10\ See CBOE Rule 30.4(c) which provides that the ``hours 
during which transactions in * * * UIT interest may be made on the 
Exchange shall be as provided in Rule 24.6 in respect of index 
options.'' Rule 24.6 provides a 3:15 p.m. closing time.
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Redemption

    IPRs will be redeemable in kind by tendering them to the Trustee, 
but only in Creation Unit aggregations. While holders may sell any 
number of IPRs in the secondary market at any time, they must 
accumulate a minimum number of IPRs equal to a Creation Unit in order 
to redeem through a Trust. IPRs will remain outstanding until redeemed 
or until termination of the Trust by which they were issued. Creation 
Units of a Trust will be redeemable on any business day in exchange for 
a portfolio of the securities held by the Trust substantially identical 
in weighing and composition to the securities portion of the Portfolio 
Deposit for such Trust in effect on the date request is made for 
redemption, together with the Cash Component. The number of shares of 
each of the securities transferred to the redeeming holder will be the 
number of shares of each of the component stocks in such a Portfolio 
Deposit on the day the redemption notice is received by the Trustee, 
multiplied by the number of Creation Units being redeemed. Nominal 
service fees will be charged in connection with the creation and 
redemption of Creation Units. The Trustee will cancel all tendered 
Creation Units upon redemption.

Distributions

    The Trusts will pay dividends quarterly. It is expected that the 
regular quarterly ex-dividend dates for an underlying index or 
portfolio of securities traded on the New York Stock Exchange, Inc. 
(``NYSE'') will be the third Friday in March, June, September and 
December, unless such day is an NYSE holiday, in which case the ex-

[[Page 5581]]

 dividend date will be the preceding Thursday. Holders of IPRs on the 
business day preceding the ex-dividend date will be entitled to receive 
an amount representing dividends accumulated through the quarterly 
dividend period preceding such ex-dividend date net of fees and 
expenses for such period. The payment of dividends will be made on the 
last Exchange business day in the calendar month following the ex-
dividend date (``Dividend Payment Date''). On the Dividend Payment 
Date, dividends payable will be distributed for those securities with 
ex-dividend dates falling within the period from the ex-dividend date 
most recently preceding the current ex-dividend date through the 
business day preceding the current ex-dividend date.\11\ The Trustee 
will compute on a daily basis the dividends accumulated for each Trust 
within each quarterly dividend period. Dividend payments will be made 
through DTC and its participants to all such holders with funds 
received from the Trustee. IPRs will be registered in book entry form 
only, which records will be kept by DTC.
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    \11\ Because the Trusts intend to qualify for and elect tax 
treatment as regulated investment companies under the Internal 
Revenue Code, the Trustee will also be required to make additional 
distributions to the minimum extent necessary (i) to distribute the 
entire annual taxable income of each Trust, including any net 
capital gains from sales of securities in connection with 
adjustments to the portfolio of securities held by such Trust, or to 
generate cash for distributions, and (ii) to avoid imposition of the 
excise tax imposed by Section 4982 of the Internal Revenue Code.
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Criteria for Initial and Continued Listing

    The CBOE's proposed standards for listing and delisting of IPRs 
allow some flexibility in listing each series of IPRs. With respect to 
initial listing, the Exchange proposes that, for each series, the 
Exchange will establish a minimum number of IPRs required to be 
outstanding at the time of commencement of Exchange trading. For IPRs 
having a Creation Unit size of 50,000 IPRs, a minimum of 150,000 IPRs 
of each such series (i.e., three Creation Units) will be required to be 
outstanding when trading on such series of IPRs begins.
    Because the Trusts operate on an open-end basis, and because the 
number of holders of IPRs of each Trust is subject to substantial 
fluctuation depending on market conditions, the Exchange believes it 
would be inappropriate and burdensome on IPR holders to consider 
suspending trading in or delisting a series of IPRs, with the 
consequent termination of the Trust by which they were issued, unless 
the number of holders remains severely depressed during an extended 
time period. Therefore, following twelve months from the formation of a 
Trust and commencement of Exchange trading, the Exchange will consider 
suspension of trading in, or removal from listing of, IPRs of any 
series when, in its opinion, further dealing in such securities appears 
unwarranted under the following circumstances:
    (a) The Trust by which IPRs of such series are issued has more than 
60 days remaining until termination and there have been fewer than 50 
record and/or beneficial holders of IPRs of such series for 30 or more 
consecutive trading days; or
    (b) The index on which the Trust is based is no longer calculated 
or available; or
    (c) Such other event shall occur or condition exist which, in the 
opinion of the Exchange, makes further dealings on the Exchange 
inadvisable.
    A Trust shall terminate upon removal from Exchange listing, and the 
series of IPRs representing interests in such Trust will be redeemed as 
described in the prospectus for such series. A Trust may also terminate 
under such other conditions as may be described in the prospectus for 
such series. For example, the Sponsor, following notice to IPR holders, 
will have discretion to direct that a Trust be terminated if the value 
of securities held by such Trust falls below a specified amount. A 
Trust based on an index or portfolio licensed to the Exchange by a 
third party will also terminate if the required license terminates.\12\
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    \12\ See supra note 8.
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Trading Halts

    Prior to commencement of trading in IPRs, the Exchange will issue a 
circular to members informing them of Exchange policies regarding 
trading halts in such securities. The circular will make clear that, in 
addition to other factors that may be relevant, the Exchange may 
consider factors such as those set forth in Exchange Rule 24.7 in 
exercising its discretion to halt or suspend trading. These factors 
would include whether trading has been halted or suspended in the 
primary market(s) for any combination of underlying stocks accounting 
for 20% or more of the value of the applicable current index group or 
whether other unusual conditions or circumstances detrimental to the 
maintenance of a fair and orderly market are present. Also, IPR trading 
would be halted (along with trading in other securities on the 
Exchange) if the circuit breaker parameters under Exchange Rule 6.3B 
are reached.

Terms and Characteristics

    The Exchange proposes to require that members and member 
organizations provide to all purchasers of each series of IPRs a 
written description of the terms and characteristics of such 
securities, in a form prepared by the Exchange, not later than the time 
a confirmation of the first transaction in each series is delivered to 
such purchaser. The Exchange also proposes to require that such 
description be included with any sales material on that series of IPRs 
that is provided to customers or the public. In addition, the Exchange 
proposes to require that any other written materials provided by a 
member or member organization to customers or the public making 
reference to a specific series of IPRs as an investment vehicle must 
include a statement in substantially the following form: ``A circular 
describing the terms and characteristics of [the series of IPRs] is 
available from your broker or the Exchange. It is recommended that you 
obtain and review such circular before purchasing [the series of IPRs]. 
In addition, upon request you may obtain from your broker a prospectus 
for [the series of IPRs].'' Finally, as noted above, the Exchange 
requires that members and member organizations provide the prospectus 
for a series of IPRs to customers upon request.
    A member or member organization carrying an omnibus account for a 
non-member broker-dealer is required to inform such non-member that 
execution of an order to purchase IPRs for such omnibus account will be 
deemed to constitute an agreement by the non-member to make such 
written description available to its customers on the same terms as are 
applicable to members and member organizations.

Trading of IPRs

    Dealings in IPRs on the Exchange will be conducted pursuant to the 
Exchange's rules governing the trading of equity securities in general. 
The Exchange's general dealing and settlement rules will apply, 
including its rules on clearance and settlement of securities 
transactions and its equity margin rules. Other generally applicable 
Exchange equity rules and procedures will also apply, including, among 
others, rules governing the priority, parity and precedence of orders 
and the responsibilities of market-makers.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with

[[Page 5582]]

the requirements of the Act and the rules and regulations thereunder 
applicable to a national securities exchange, and, in particular, with 
the requirements of Section 6(b)(5).\13\ The Commission believes that 
providing for the exchange-trading on the CBOE and IPRs will offer 
investors an efficient way of participating in the securities markets. 
In particular, the Commission believes that the trading on the CBOE and 
IPRs will provide investors with increased flexibility in satisfying 
their investment needs by allowing them to purchase and sell a low-cost 
security replicating the performance of a portfolio of stocks at 
negotiated prices throughout the business day.\14\ The Commission also 
believes that IPRs will benefit investors by allowing them to trade 
securities based on unit investment trusts in secondary market 
transactions.\15\
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    \13\ 15 U.S.C. 78f(b)(5).
    \14\ Pursuant to Section 6(b)(5) of the Act, the Commission must 
predicate approval of exchange trading for new products upon a 
finding that the introduction of the product is in the public 
interest. Such a finding would be difficult with respect to a 
product that served no investment, hedging or other economic 
function, because any benefits that might be derived by market 
participants would likely be outweighed by the potential for 
manipulation, diminished public confidence in the integrity of the 
markets, and other valid regulatory concerns.
    \15\ The Commission notes, however, that unlike open-end funds 
where investors have the right to redeem their fund shares on a 
daily basis, investors could only redeem IPRs in creation unit share 
sizes. Nevertheless, IPRs would have the added benefit of liquidity 
from the secondary market and IPR holders, unlike holders of most 
other open-end funds, would be able to dispose of their shares in a 
secondary market transaction.
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    The Commission believes that the trading on the CBOE of a security 
like IPRs, which replicate the performance of an index or portfolio of 
stocks, could benefit the equities markets by, among other things, 
helping to ameliorate the volatility occasionally experienced in such 
markets. The Commission believes that the creation of one or more 
products where actual portfolios of stocks or instruments representing 
a portfolio of stocks, such as IPRs, can trade at a single location in 
an auction market environment could alter the dynamics of program 
trading, because the availability of such single transaction portfolio 
trading could, in effect, restore the execution of program trades to 
more traditional block trading techniques.\16\
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    \16\ Program trading is defined as index arbitrage or any 
trading strategy involving the related purchase or sale of a 
``basket'' or group of fifteen or more stocks having a total market 
value of $1 million or more.
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    The 1987 Market Break Report noted the potential benefits to be 
derived from providing a market where institutional investors and 
member firms could focus their equity transactions at posts trading a 
portfolio of stocks in a single transaction. In particular, the 1987 
Market Break Report noted that the specialist(s) and the trading 
crowd(s) at the portfolio post could provide additional liquidity, that 
is currently unavailable at the posts for trading in each of the 
individual stocks, as well as provide the additional efficiencies 
associated with effecting a single transaction in a portfolio of 
securities as opposed to numerous transactions in individual stocks. 
The additional layer of liquidity to the market could help absorb the 
velocity and concentration of trading associated with index-related 
trading strategies involving individual stocks. Because market 
portfolio instruments would be traded at a single location on an 
exchange floor, the potentially adverse effects of program trading 
order flows during volatile market conditions, such as imbalances in 
particular stocks, would be diminished. Moreover, the trading of a 
single security replicating the performance of a broad portfolio of 
stocks, in general, will provide an easy and inexpensive methods to 
clear and settle a portfolio of stocks. Accordingly, given the design 
of the IPRs in general, the Commission believes that the benefits to 
the marketplace noted above resulting from the trading of a ``basket'' 
product likely will result from the trading of IPRs.
    The Commission also believes that IPRs will provide investors with 
several advantages over standard open-end index mutual fund shares. In 
particular, provided the necessary Investment Company Act relief is 
obtained, investors will have the ability to trade IPRs continuously 
throughout the business day in secondary market transactions at 
negotiated prices.\17\ In contrast, pursuant to Investment Company Act 
Rule 22c-1,\18\ holders and prospective holders of open-end mutual fund 
shares are limited to purchasing or redeeming securities of the fund 
based on the net asset value of the securities held by the fund as 
designated by the board of directors.\19\ Accordingly, IPRs will allow 
investors to (1) respond quickly to changes in the market; (2) trade at 
a known price; (3) engage in hedging strategies nor currently available 
to retail investors; and (4) reduce transaction costs for trading a 
portfolio of securities.
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    \17\ Because of potential arbitrage opportunities, the 
Commission believes that IPRs will not trade at a material discount 
or premium in relation to their net asset value. The mere potential 
for arbitrage should keep the market price of IPRs comparable to 
their net asset value, and therefore, arbitrage activity likely will 
be minimal. In addition, the Commission believes a Trust generally 
should track is underlying index more closely than an open-end index 
fund because a Trust will accept only in-kind deposits, and, 
therefore, will not incur brokerage expenses in assembling its 
portfolio. In addition, a Trust will redeem only in kind, thereby 
enabling the Trust to invest virtually all of its assets in 
securities comprising the underlying index.
    \18\ Investment Company Act Rule 22c-1 generally requires that a 
registered investment company issuing a redeemable security, its 
principle underwriter, and dealers in that security, may sell, 
redeem, or repurchase the security only at a price based on the net 
asset value next computed after receipt of an investor's request to 
purchase, redeem, or resell. The net asset value of a mutual fund 
generally is computed once daily Monday through Friday as designated 
by the investment company's board of directors. The Commission notes 
that the CBOE would need to apply for an exemption to allow 
particular IPR products to trade at negotiated prices in the 
secondary market.
    \19\ Id.
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    Although IPRs are not leveraged instruments, and, therefore, do not 
possess any of the attributes of stock index options, their prices will 
still be derived and based upon the securities held in their respective 
Trusts. In essence, IPRs are equity securities that are priced off a 
portfolio of stocks based on a selected index or basket of stocks. 
Accordingly, the level of risk involved in the purchase or sale of an 
IPR is similar to the risk involved in the purchase or sale of 
traditional common stock, with the exception that the pricing mechanism 
for IPRs is based on a basket of stocks. Nonetheless, the Commission 
has several specific concerns regarding the trading of these 
securities. In particular, IPRs raise disclosure, market impact, and 
secondary market trading issues that must be addressed adequately. As 
discussed in more detail below, the Commission believes the CBOE has 
adequately addressed these concerns.

Disclosure

    The Commission believes that the CBOE proposal contains several 
provisions that will ensure that investors are adequately apprised of 
the terms, characteristics, and risks of trading IPRs. As noted above, 
the proposal contains four aspects addressing disclosure concerns. 
First, CBOE members must provide their customers trading IPRs with a 
written explanation of any special characteristics and risks attendant 
to trading such IPR securities, in a form approved by the CBOE.\20\ 
Second, members and member organizations must include this written 
product description with any sales material relating to the series of 
IPRs that is

[[Page 5583]]

provided to customers or the public. Third, any other written materials 
provided by a member or member organization to customers or the public 
referencing IPRs as an investment vehicle must include a statement, in 
a form specified by the CBOE, that a circular and prospectus are 
available from a broker upon request. A member or member organization 
carrying an omnibus account for a non-member broker-dealer is required 
to inform such non-member that execution of an order to purchase a 
series of IPRs for such omnibus account will be deemed to constitute 
agreement by the non-member to make the written product description 
available to its customers on the same terms as member firms. 
Accordingly, the Commission believes that investors in IPR securities 
will be provided with adequate disclosure of the unique characteristics 
of the IPR instruments and other relevant information pertaining to the 
instruments. Fourth, CBOE Rule 30.50, Doing Business with the Public, 
which includes customer suitability provisions, will apply to the 
trading of IPRs.\21\
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    \20\ The Commission notes that the CBOE will be required to 
prepare a product description for members and submit it to the 
Division for review prior to listing and trading any IPR product.
    \21\ CBOE Rule 30.50 provides, in part, that every member 
organization shall use due diligence to learn the essential facts 
relative to every customer and to every order or account accepted 
and shall supervise diligently the handling of all customer 
accounts. Rule 30.50 Interpretations, and Policies .02 further 
provides, in part, that customers should be provided with an 
explanation of any special characteristics and risks attendant to 
trading UIT interests.
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Market Impact

    The Commission believes the CBOE has adequately addressed the 
potential market impact concerns raised by the proposal. The CBOE has 
developed policies regarding trading halts in IPRs. Specifically, the 
Exchange would halt IPR trading if the circuit breaker parameters under 
CBOE Rule 6.3B were reached. In addition, in deciding whether to halt 
trading or conduct a delayed opening in IPRs, the CBOE represents that 
it will be guided by, but not necessarily bound to, relevant stock 
index option trading rules. Specifically, consistent with CBOE Rule 
24.7, the CBOE may consider whether trading has been halted or 
suspended in the primary market(s) for any combination of underlying 
stocks accounting for 20% or more of the applicable current index group 
value or whether other unusual conditions or circumstances detrimental 
to the maintenance of a fair and orderly market are present.
    The CBOE has not proposed at this time a specific IPR that it 
intends to trade. The CBOE's proposed listing standards provide it with 
broad authority to list IPRs ``based on one or more stock indices or 
securities portfolios.'' Accordingly, it is difficult for the 
Commission to assess the potential market impact of trading a 
particular IPR series. To date, several products nearly identical to 
IPRs, notably Standard & Poor's Depositary Receipts (``SPDRs'') and 
Standard & Poor's MidCap 400 Depositary Receipts (``MidCap SPDRs'') 
trade on one or more U.S. exchanges. These products have not adversely 
impacted U.S. equities markets. In fact, such products appear to 
provide substantial benefits to the marketplace and investors, 
including, among others, enhancing the stability of the markets for 
individual stocks. All of the current approved/traded IPR-like 
products, however, are based on broad-based stock indices containing 
large capitalized, liquid stocks.
    IPRs theoretically can serve as substitutes for transactions in the 
cash market, resulting in order flow in individual stocks smaller than 
would otherwise be the case. Such an occurrence is more likely to cause 
a noticeable market impact where the subject stocks have relatively low 
capitalization and are liquid. As a result, the Commission believes 
that the CBOE should contact the Division and provide it with advance 
notice of the listing of a specific IPR. The Division may determine 
that a rule filing, pursuant to Section 19 of the Act, will be required 
in order to approve a particular index or portfolio as appropriate for 
IPR trading.

Trading Rules

    The Commission finds that the CBOE's proposal contains adequate 
rules and procedures to govern the trading of IPR securities. IPRs are 
Unit Investment Trust (``UIT'') securities, which, under CBOE rules, 
subjects them to the fully panoply of rules governing the trading of 
such securities on the CBOE, including, among others, rules governing 
the priority, parity and precedence of orders and the responsibilities 
of market-makers.\22\ IPRs will also be subject to the same margin 
requirements as equity securities.\23\ Further, the Commission notes 
that the CBOE has submitted surveillance procedures for the trading of 
IPRs and believes that those procedures, which incorporate and rely 
upon existing CBOE surveillance procedures governing equities, are 
adequate under the Act. In addition, the CBOE has developed specific 
listing and delisting criteria for IPRs that will help to ensure that 
the markets for IPRs will be deep and liquid. As noted above, the 
CBOE's proposal provides for trading halt procedures governing IPRs. 
Finally, the Commission notes that CBOE Rule 30.50, Doing Business with 
the Public, which includes customer suitability provisions, will apply 
to the trading of IPRs in general.
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    \22\ Telephone conversation between James McDaniel, Schiff, 
Hardin & Waite (CBOE counsel), and Kevin Ehrlich, Attorney, 
Division, Commission (January 22, 1998).
    \23\ Telephone conversation between James McDaniel, Schiff, 
Hardin & Waiter (CBOE counsel), and Kevin Ehrlich, Attorney, 
Division, Commission (January 22, 1998).
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    The CBOE has not represented that it intends to trade IPRs (or 
securities traded on other exchanges that are nearly identical to IPRs) 
pursuant to unlisted trading privileges. However, if the CBOE chose to 
trade instruments such as SPDRs and MidCap SPDRs pursuant to unlisted 
trading privileges, adoption of IPR listing standards satisfies Rule 
12f-5 of the Act which requires that an exchange have in effect ``rules 
providing for transactions in the class or type of security to which 
the exchange extends unlisted trading privileges.'' Nevertheless, prior 
to trading IPRs (or similar securities) pursuant to unlisted trading 
privileges, the CBOE should make certain that it has adequately 
addressed other potential issues, and particularly, should ensure that 
the required product description is made available to investors.\24\ 
The Commission notes that while the CBOE would not be required to make 
further 19(b) rule filings to trade PDRs pursuant to UTP, the CBOE 
should submit materials such as the relevant product description and 
circular to Division staff for review prior to commencing trading.
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    \24\ For a more detailed description of potential unlisted 
trading privilege-related issues, see Release Nos. 39076 (Sept. 15, 
1997), 62 FR 49270 (Sept. 19, 1997) (``CHX Approval Order''); 39268 
(Oct. 22, 1997), 62 FR 56211 (Oct. 29, 1997) (``CSE Approval 
Order''); 39461 (Dec. 17, 1997), 62 FR 6764 (Dec. 29, 1997) (``PCX 
Approval Order'').
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IV. Conclusion

    The Commission finds that the listing and trading of IPRs is 
consisent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange, 
and, in particular, the requirements of Section 6(b)(5). As discussed 
above, the trading of IPRs should provide a variety of benefits to the 
marketplace and investors trading portfolios of securities. 
Accordingly, the Commission believes that IPRs will serve to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and,

[[Page 5584]]

protect investors and the public interest.\25\
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    \25\ In approving this rule, the Commission has consisted the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    The Commission finds good cause to approve Amendment No. 1 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 1 withdraws from the proposed rule change a proposed 
general exemption of IPRs from the Exchange's short sale rule. The CBOE 
originally anticipated that the Commission would grant a general 
exemption from Rule 10a-1 of the Act for all IPRs prior to the approval 
of this filing. However, to date, such an exemption has not been 
granted. Accordingly, the Commission believes that there is good cause, 
consistent with Section 6(b)(5) of the Act, to approve Amendment No. 1 
to the proposal on an accelerated basis.
    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1, including whether this proposed 
amendment is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any other person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 522, will be available for inspection 
and copying at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submission should refer to File 
No. SR-CBOE-97-38 and should be submitted by February 24, 1998.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (SR-CBOE-97-38) is approved, as 
amended.

    \26\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-2524 Filed 2-2-98; 8:45 am]
BILLING CODE 8010-01-M